C. Boyden Gray and Adam J. White

Mitt Romney was right: Dodd-Frank is a gift to big banks

Big Wall Street banks caused a financial crisis and brought the nation to the brink of economic collapse; President Obama signed the Dodd-Frank Act to punish those banks and end government bailouts of too-big-to-fail financial institutions.

That’s what President Obama believes, at least. He said so when he signed Dodd-Frank into law on July 21, 2010: Wall Street banks long had tricked Americans with fine-print traps, opaque investment pitches, and “abusive practices in the mortgage industry,” but Dodd-Frank would foster transparency and competition, and “make sure that everybody follows the same set of rules.” Wall Street banks had used the threat of systemic financial collapse to extort bailouts from the public, but Dodd-Frank would ensure that “the American people will never again be asked to foot the bill for Wall Street’s mistakes.” Above all else, there would be “no dividing line between Main Street and Wall Street. We rise or fall together as one nation” under Dodd-Frank.

So you can imagine the president’s frustration two years later, when he stood onstage at the first of three presidential debates and heard his opponent paint a very different picture. Said Mitt Romney:

Dodd-Frank was passed. And it includes within it a number of provisions that I think [have] some unintended consequences that are harmful to the economy. One is it designates a number of banks as too big to fail, and the y’re effectively guaranteed by the federal government. This is the biggest kiss that’s been given to—to New York banks I’ve ever seen.

Romney was launching a direct assault not just on Dodd-Frank, but also on the conventional wisdom that Dodd-Frank punished Wall Street.

If President Obama was frustrated by this sharp criticism of one of the administration’s landmark legislative achievements, he was not alone. The New Republic’s Alec MacGillis lambasted “the full chutzpah of Romney’s move,” “attempting to paint Obama as a crony of the biggest banks” despite bankers’ political contributions to Republicans. Elsewhere, Sheila Bair, former chairman of the Federal Deposit Insurance Corporation, called Romney’s comments “misinformed.”

If Romney touched a nerve, it was not because he was contrarian, but because he was correct. As many analysts and officials have explained, Dodd-Frank subsidizes large, influential Wall Street financial institutions, while imposing disproportionately heavy burdens on Main Street banks and the communities they serve. Even if we take President Obama, Senator Dodd, Representative Frank, and the rest of Dodd-Frank’s supporters at face value when they protest that they actually intended to rein in Wall Street banks, the laws they passed accomplish the opposite result. Intentional or not, a kiss is still a kiss.

Governor Romney’s criticisms targeted the parts of Dodd-Frank that were ostensibly enacted to limit the power of too-big-to-fail financial institutions. Title I creates the Financial Stability Oversight Council, an interagency board that will formally designate certain large banks and nonbank financial companies as “systemically important financial institutions” (SIFIs). Title II creates the Orderly Liquidation Authority, by which the Treasury secretary and the FDIC are empowered to “liquidate” troubled SIFIs.

By granting federal bureaucrats open-ended power and insulating them against crucial checks and balances, these provisions present grave constitutional concerns, which are the subject of a federal lawsuit filed recently by private plaintiffs and three states. More significant for present purposes, Titles I and II exacerbate the very problem they were purported to solve: the dangerous power of financial institutions that are treated as too big to fail.

According to the Treasury secretary, who chairs the Financial Stability Oversight Council, the council will soon begin designating large financial institutions as “systemically important.” When it does, the council will be making official a status that before Dodd-Frank was strictly unofficial and conjectural.

Official SIFI status will be worth billions of dollars to the companies that receive it, as demonstrated by the ever-heightening mountain of research that has attempted to quantify its benefits. Before Dodd-Frank, a handful of big banks enjoyed unofficial too-big-to-fail status among investors, simply because of the banks’ disproportionate size—$100 billion in assets was a common benchmark. Because those banks were seen as enjoying the likely protection of government intervention to prevent their failure, investors saw the banks as less risky than their “small enough to fail” competitors. Accordingly, the big banks were able to attract investment capital at much lower cost.